Series 4 Episode 4 - A view from the continent: A year of regulatory reform and the European perspective

Transcript

Andrew Strange: Hello everyone, and welcome to our first episode of Risk and Regulation Rundown for 2023, giving you our latest insight and analysis on hot topics in financial services risk and regulation. I'm Andrew Strange and I lead our UK financial services regulatory insights team and I'm your usual host. As we kick off the new year, we wanted to talk about some of the changes in financial services in the UK this year. With the extensive Edinburgh Reforms published in December, this felt like a timely opportunity to consider the implications, the challenges and the opportunities for firms. But we obviously don't work in a UK-centric vacuum, so we've made sure we have a guest to give it an external perspective on some of these changes. I'm therefore delighted to be joined by two guests, Conor MacManus, a Director in the financial services regulatory insights team and Michael Huertas, a Partner from PwC Germany and PwC's financial services legal leader in Europe. Michael is joining us remotely, so please do excuse any sound difference that you hear, so morning both.

Conor MacManus: Morning.

Michael Huertas: Hello, happy to be here. Thanks for having me.

Andrew: So, Conor, let's start with the Edinburgh Reforms, then. We've heard a lot since last month on Brexit dividends and deregulation. Is that what we've got?

Conor: Well, I mean, we'll have to see about the dividend that the package provides the financial services sector over time but it's certainly an ambitious scope of reforms which were announced by the government on 9 December. I mean, I think there was around 30 announcements, some of which were re-announcements, but a huge amount played and things which will touch on almost every aspect of the financial services ecosystem from consumer credit, right through to financial market infrastructures using distributed ledger technology. So, I think that gives you a sense of the scope of the package. I mean, in terms of the deregulatory agenda, clearly the focus is to remove burdens where possible. That's not just around EU regulations though. For example, we've had some announcements around ring-fencing which were expected. A review of the senior manager's regime which are obviously UK pieces of regulation, but yes, a process which will be undertaken and looking at EU regulation and seeing whether it's appropriate for the UK market and making changes if necessary.

Andrew: Thanks, Conor. Yes, very interesting. We've seen a lot of noise and a lot of attention given to these reforms in the UK but Michael, how much attention has there been from EU authorities and from people on the other side of the channel on this?

Michael: It's a great question. I think there's been, some different levels of enthusiasm in terms of awaiting the change. The change has been a long time coming, so there's obviously been some relief that the government in the United Kingdom has decided to publish its proposals. Then that's where enthusiasm starts to differ in terms of the actual content of the proposals. There are those that are concerned at a policy making level in the EU about what these changes mean for the UK's position in the wider sense of Europe. So, not just Europe and European Union but certainly, Europe outside of the European Union, I think specifically the proposal for the UK to build closer relationships with Switzerland, as well as a couple of other jurisdictions. So, I think there's some concern there and I think we'll touch upon that later on. But there has also been a sense of relief that some of the changes that have been proposed are perhaps not as drastic as would have been feared. So now policymakers in the European Union are also assessing what this divergence might mean, whether there are any lessons that can be learned from the UK's current proposals and ultimately, how much the UK is going to make a success of what they're putting forth because, of course, whilst the Brexit dividend perhaps remains to be seen in full, divergence is an opportunity for the EU itself to consider what it will do next and also consider how it will engage with UK policymakers as both sides of the English Channel and the Irish Sea move to a much more cemented relationship post-Brexit.

Andrew: Thank you, Michael. Okay, so, Conor, let's have a look at some of the specifics of the sensible and pragmatic proposals. What are the standout announcements for you and what impact could they have?

Conor: Yes, I mean, so, as I said, you know, there's a huge amount in the announcements from 9th December but I think you can probably group them into three categories. One is, as I mentioned, looking at pieces of UK regulation and questioning whether they are still appropriate and where the burdens can be reduced in them. So probably the most notable examples there are the ring-fencing reforms. So that's about bringing those banks which have very limited trading activities out of scope of the regime, increasing the threshold in which a bank comes into scope of the regime and looking at, over a longer time period, how it aligns with the resolution regime. We've also got the announcement of a review of the senior managers regime. So, this is, you know, a kind of, iconic part of the UK regulatory framework in some ways, been in force for a number of years but the government asking the regulators to review whether it could be made more proportionate, we don't know where that's going to go but that's a very interesting development.

Andrew: I was going to say, the announcement of a review doesn't sound like the most tangible of actions for anybody to take.

Conor: Well, yes, exactly. I mean, we'll see, I think that the review is committed for Q1 so we'll get some further details quite soon, I would have thought. So, that's the first bucket of reforms, the kind of, UK specific stuff and then you've got, as I said, the process of looking at EU-derived regulations, all those acronyms that we're all so familiar with, Solvency II, MiFID, PRIIPs, and asking the question of whether those EU-derived pieces of regulation are appropriate for the UK market and whether there are changes that should be made. Some of the areas we know that they're looking to change, so, there's been a lot of focus on Solvency II. The wholesale markets review has been focusing on MiFID and we've got quite a lot of detail in that space. We know, for example, that the government is committed to getting rid of PRIIPs and replacing it with something else but there's going to be a much broader process of looking at all of those pieces of EU regulation over a time and looking at whether changes need to be made. And then I think the third, kind of, group of announcements which are really interesting is around responding to technological change in innovation and particularly around change and innovation in wholesale markets. So, I mentioned that they're launching an FMI sandbox which will allow FMI's to use technology like distributed ledger technology. That's quite interesting. They're looking at how settlement of trades can be made more efficient for example as well. Again, quite an interesting development and you can see that this is the government really looking at how can they make UK capital markets as tech enabled and innovative and efficient as possible? This is a really interesting area of focus but it's one that's going to take a while to really come to fruition, I think.

Andrew: Okay, thank you. Very interesting. Michael, obviously, clients are operating in multiple regimes. So, what are you actually hearing from your clients in Europe in response to the UK's regulatory agenda?

Michael: Well, I think the main discussion is currently how much divergence will actually translate into increased costs of how you do your business on both sides of the English Channel and the Irish Sea. That's something which is certainly becoming quite tangible across a number of areas where there was historically close alignment. In particular, on the securitisation regulation, how that was implemented on both sides with Brexit already on the cards. And where both policymakers were working together towards a common goal, there now seems to be quite a degree of divergence. So, whilst I fully agree with Conor that there are a number of elements which will perhaps be UK-specific in focus and reforms will be designed to alleviate market burdens and operating costs in the UK, that indeed could drive up costs for a number of firms regardless of where they're headquartered. So, there's a number of, sort of, questions of change is good but change is costly and just how much will that actually translate into efforts that perhaps certain firms do not want to duplicate but need to. Then there's the policymaker side of the discussion which has been quite clear with a number of financial services firms, certainly amongst those that are involved in the banking sector as part of the desk mapping review which of course looked at the adequacy of post-Brexit operating plans of major banks and in a sense that there is still a lot of work to be done in order to meet the European Union supervisory expectations on how you operate your target operating model in a post-Brexit world. And of course, these announcements, whilst some of them may be welcome and some of them may prove that the EU could perhaps drive forward similar types of changes to alleviate market burden, there is still this fear amongst EU policymakers that the UK is pursuing a regulatory race to the bottom, which of course raises a number of political questions which have to be worked out between policymakers in the respective forums. The main point is, change is, of course, welcome but the price tag of that change is still very much a big question mark around it.

Conor: Yes, I mean, I would absolutely agree with what Michael says there. I mean, making regulation more proportionate and more appropriate and responding to market developments is clearly the right thing to do but there has to be quite a robust cost-benefit analysis in terms of whether making a change is worth it. I think the other area to think about here is the time period over which these changes are going to be made. So, as I said, they've committed the government and the regulators to move those EU-derived pieces of regulation which currently sit in parliamentary legislation into the regulators rule books. That's going to be an enormous undertaking for the regulators and the industry and, you know, what they've said is that they'll try and make significant progress on that next year. Now obviously, you know, that's a relatively vague commitment but I think there does need to be a recognition that there's only so much change that the regulatory system, in its broadest sense, can deal with over a short period of time. I mean, and also on the de-regulatory narrative, if you like and the discussion on that, I think it is worth recognising as well that it's not just one way traffic here in the UK. There's also other areas where the UK is continuing to be stricter from a regulatory perspective than many other jurisdictions. So, a good example of that would be the Basel 3.1 proposals which the PRA published at the end of November. You know, they've stuck pretty closely to the Basel Committee rules whereas the EU has moved away in a number of areas. And, of course, we've got the consumer duty coming in in the UK which is, you know, a very robust piece of regulation. So, I think the reality is perhaps a little bit more nuanced than some of the. kind of, political narratives suggest.

Andrew: Yes, thanks, Conor. That's really interesting and, you know, the reality is, even good change costs money. I mean, it's tough for our clients. So, I mean, clearly the regulatory agenda extends wider than some of the Edinburgh reforms we saw at the end of last year. I feel like that, kind of, unblocked a number of the announcements that we saw towards the end of the year. So, we saw the Bank of England's approach to systemic risk in the non-bank sector. The UK's continuing to develop its approach to critical third-party providers, for example. Conor, how do you see this sort of broader agenda progressing in the UK and Michael, I'd be interested to hear your perspective on some of those issues from a European perspective too.

Conor: Yes, I mean, it's really interesting. You know, as you'd expect, the regulators are responding to circumstances which are challenging at the moment from various perspectives and the two examples you give are quite good examples of them responding to risks which we've seen in the market. You know, we've had a lot of volatility in the UK in recent months and that has revealed some vulnerabilities in the markets but also innovation and technological change. So, you know, greater concentration on critical third parties such as Cloud service providers. So, I think it just reinforces the point that the regulators are responding to lots of different factors and we've seen that for a number of years and the consequence of that is that the regulatory landscape, if you like, is getting broader and broader and that's something that I think firms will just have to deal with. I mean, on the two specific points you raise, you know, clearly the volatility and the gilt markets in particular over the past couple of months was quite challenging. As you'd expect, the Bank of England is responding to that. There's a broader non-bank agenda which is being taken forward at international level through the FSB but we saw an announcement from the financial policy committee in December around a stress test for the first time of those non-bank actors in the market, which just shows the increased focus from a systemic risk perspective on that part of the market. Now, there's relatively little detail beyond that but I think that just reinforces the focus. And then on the critical third party piece, as I said, it's really about the regulators saying, you know, there is a systemic dependency in the market on certain critical third parties, we need to have oversight and assurance over the resilience of that part of the financial services ecosystem. So there's a discussion paper which closed at the end of 2022 on that. We're expecting a consultation in 2023 at some point to take those proposals forward in more detail, but again this is an example of divergence between the UK and the EU. I mean, Michael can talk about DORA which is the EU equivalent to this focus in the UK but we're seeing, again, an approach which is similar but a bit different between the UK and the EU, which is to be expected but brings some challenges for firms.

Michael: Yes, I think specifically for firms, as you say, Conor, whilst the end destination of how you get to improving third party resilience and how you document that and how you stress test that, whilst there's common agreement on common principles, the devil is in the detail and that's where divergence can become quite costly. So, for most firms, I think one of the challenges has been, you know, if we take a step back, right, most of the financial markets have come back from the pause that was introduced by the COVID-19 pandemic to a flurry of rule-making on both sides of the EU/UK wider debate on what does the post-Brexit operating environment look like. That's put a lot of challenge for firms, it's put a lot of challenge for policymakers and it's put obviously a lot of challenge for supervisory authorities at the EU level and then at the national level. To add to that complexity, of course, as you've already said, are the increased market volatility, some due to some political home-grown problems in the UK but then obviously, the wider impact of the conflict in Ukraine. Really, during 2022, haven't had much of a pause for breath and firms are getting, smarter about how they approach a lot of what needs doing in terms of finding where are the common principles that one can establish to meet both of the rule makers and the supervisory outcomes. Of course, there are a lot of solutions and a lot of tools that are available that are coming to fruition. I think that's where firms should be concentrating as 2023 progresses because it's unlikely that we're going to have some sort of pause any time soon. It's unlikely that even with the UK's approach to making a number of the rules more workable, that that's necessarily going to meet that compliance is going to be cheaper. It's just going to take a different form and ultimately, once we look at the divergence between the UK and the EU, that's only one set of factors. We have to obviously consider then the global agenda, there are also different pockets of regulatory reform that have a much wider impact. So, developments out of the United States but then also developments in certain other jurisdictions in which a number of firms might be active across Asia Pacific and all of that really puts firms under pressure and getting ahead of that will hold them in good stead to do so.

Andrew: Thank you, Michael, yes, that's really interesting, really comprehensive. I think it's interesting, if I look at some of the UK changes, you know, we're trying to get our head around how the political interaction happens with regulatory bodies in the UK in a post-Brexit world. You say no pause over 2023 but the reality is that there are EU elections on the horizon for 2024, which typically, in my experience in the past, have resulted in, you know, dossiers being tied up and finished but not necessarily a vast amount of new legislative activity. Obviously, supervisory activity goes on. I mean, is 2024 elections, are they on people's radars, what impact do you think it's going to have on the EU regulatory agenda, Michael?

Michael: Yes, it's an excellent question. I think the EU elections in 2024, the parliamentary elections will start to become more of an issue as we head towards the middle of 2023 and the preparations for the parliamentary elections start and then effectively, as you say, certain dossiers are either rushed to the finish line or they're parked for the new legislative period. One of the things that, of course, was reviewed and somewhat welcomed amongst a number of market participants in Europe is the Swedish presidency of the EU which took up its role on 1st January, taking over from the Czech presidency and very much promoting, at least in financial services, a degree of continuity, and of course, a step up on the ESG agenda. That should come as no surprise that that's a change but there is no major shocking developments on the horizon which, for once, is actually quite welcomed. So, if you look at the work programmes of each of the European supervisory authorities, a lot of it is getting some of the work done that has been delayed due to the pandemic. Getting the remainder of the Capital Markets Union 2.0/3.0 type announcements, getting those fit for purpose and at least ready for implementation and then tying up some of the bigger ticket items in terms of the work on DORA, the work on the MiFID review, getting the banking unit reform moving forward and so on and so forth. Where there is concern, it's the level two regulatory technical standards, implementing technical standards and then the level three, the FAQ's and the respective supervisory guidance that really put the meat on the bones, so to speak, that need to get done. That's where if there is a delay, that really does become costly because then we operate in a market where, yes, everyone knows what the rough environment is supposed to look like but the detail isn't finalised. Just to sum up on that point, I wouldn't say that the 2024 EU parliamentary elections are something that are actively on people's horizon as we speak now in January but it will become increasingly more important as we head towards that cycle moving forward.

Andrew: Absolutely. Conor, 2024 for us then? 2022 was a challenging year politically but a quiet year this year and then next year?

Conor: Well, indeed. I mean, as Michael eludes to, you know, there's elections coming up in the not too distant future here as well. I think, you know, for financial services, there’s two main consequences of that. I mean, that's one of the drivers of why the government is trying to make as much progress as possible on its regulatory agenda, is the election, but also, it's going to become more and more important to understand the Labour Party's position on financial services regulation. You know, if the polls are to be believed, there is a strong chance that they might be the next government. So, that obviously means their position on financial services becomes extremely important.

Andrew: Okay, and just finally then. So, looking slightly longer term, the political tone between the UK and EU seems to have improved slightly actually, in recent times. What are your own views on this and whether it could unlock any discussions on financial services between the UK and the EU? Conor, what's your perspective?

Conor: Yes, I mean, I think as you say, the tone seems to have improved in recent weeks which is obviously a good thing, that we all know the big political issue which is overshadowing the relationship is Northern Ireland. You know, if they can find an agreement on that, will it unlock progress on financial services? Potentially, but I think the question is, unlock what? You know, there's been an MOU which was agreed between the UK and EU on financial services some time ago, it was never signed because of the political issues, political problems. You could quite easily see that that might get published. Would that materially change the relationship on financial services? A little bit but not a huge amount. You know, then you get into questions around equivalence and then I think, you know, that's a much bigger question as to whether, once the political and hopefully, once the political relationship normalises, whether the EU would be prepared to engage on equivalence. I think that would be, well, remains to be seen. I'm sure Michael will have views on that.

Michael: Yes, I mean, as a long-term Londoner now back on the continent for certainly the past nine years, I'm going to be a little less optimistic about what you've just said. I think yes, the tone has become more civil, it has certainly become more about focusing on doing good things for people that need good things done for them but I don't think that's going to translate into unwinding the position that the EU has quite rightly put in place with respect to financial services. The EU position still remains, somewhat frustrated, with the number of aspects of how certain firms in the UK have been approaching what from the EU's perspective was relatively clear as the consequences of Brexit. So, I don't think they're going to be much, there'll be much in the way of an olive branch being extended. There may be some aspects that could be improved on, you've eluded to equivalence. There may be some improvements, some mutual recognition or at least some soundings that would suggest that at some point in the future one could consider it but I think that's over a much longer period than many in the London market would perhaps have hoped for and indeed, many in the continental European markets equally would hope for because it all comes back to the cost of divergence and how potentially with equivalence and mutual recognition, that could be reduced. I think one of the aspects that will be quite interesting to follow is if and when this cross-channel or cross-jurisdictional policymaker bridge is then fully operational as the MOU had originally proposed it to be and for both sides that actually say, well, you know, yes, we have alleviated some burdens but we're not looking to deregulate and effectively compete with one another, we're just looking to peacefully co-exist and actually drive economic growth. Because ultimately, that's what both policymakers on, you know, regardless of where they are on the electoral spectrum, need to count to the electorate for, in terms of economic growth. We still have serious issues in the European Union about sustainable economic growth in a number of jurisdictions and also, equality of that economic growth amongst jurisdictions and indeed, the UK has its own challenges and on both sides of the divide, financial services have an absolutely crucial element to play to drive that economic growth into reality.

I think there is a common will, regardless of whether you're in Brussels or in London or elsewhere, to make that happen but just make it happen that effectively, we still operate on a safe, efficient and sound market base or marketplace that can actually make that, you know, translate into reality for the electorate because ultimately, if not, the elections could be a very nasty surprise for a number of quite established political parties or those that have promised reform and ultimately, don't deliver. So, I think 2023 is one busy year of consolidation, setting the scene for electoral debate and then elections in 2024 and then hopefully, over the longer term, giving more of a foundation to what is supposed to be a functioning partnership amongst the EU and its non-EU neighbours but that's something which will probably take a lot longer to build than many would hope for.

Andrew: Thank you, Michael. I think we'll focus on the common desire for growth there in a safe and sustainable way. That sounds like something we can all agree on. Thank you both for joining us today. That was really interesting. I think we've set the bar really high for our series of podcasts over this year, so, well done, thank you. I'm not sure our future guests will be so thankful but it's really been interesting. To our listeners, I hope you've also enjoyed this conversation today and thank you for joining us. As always, please do subscribe to future episodes and rate and review the series, as it helps other listeners to find us. If you'd like to hear more from us on risk and regulation, please look out for our regular publications on our website, where you can also subscribe to our monthly newsletter on regulatory developments and we'll be back next month. Thank you.